Here are 5 Div 7A fixes and 5 exlusions, so 10 ways to make a Div 7A problem go away.
Div 7A Fixes
If you have a Div 7A issue, how do you fix it? You fix the problem or find an exclusion. There are 5 fixes and 5 exclusions, so in total 10 ways to ‘get out of jail’.
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This is a re-run of certain parts of the interview with Peter Adams in ep 50 to regig your memory before we proceed to Div 7a UPEs in the next episode.
Fix # 1 Pay It Back
The easiest way to fix a Div 7A is to repay the loan by the lodgement due date of the company tax return – so usually by May of the following year. If you repay the loan by May, it won’t be an unfranked dividend as of June of the previous year.
Taking out a short-term bank loan to repay it as of May won’t count. It is not possible to avoid Div 7A through a regular roll over of a bank credit. But paying it back out of salary and wages or dividends, ie out of profit, does count.
Fix # 2 Make It Commercial
A Div 7A loan won’t be treated as an unfranked dividend, if you make it a proper commercial loan that has the same conditions as a normal commercial loan with a maximum loan period of currently 7 years (or 10 years if secured by a mortgage). You need to document the loan as per s109N ITAA36 and charge at least the benchmark interest rate.
You also need to make minimum repayments. If there is a shortfall of a minimum repayment, only the shortfall becomes a Div 7A dividend, not the entire loan.
Fix # 3 Reduce Distributable Surplus
A Div 7A dividend is only taxable if there is a distributable surplus. So if your distributable surplus in the year you make a Div 7A loan, payment or debt forgiveness is nil, no tax is payable on that Div 7A amount – ever.
The unfranked deemed dividend can never be more than the distributable surplus. The distributable surplus out is an absolute out. It doesn’t matter that next year your distributable surplus is 5 million. All that matters is the amount of distributable surplus in the year the loan is made.
Fix # 4 Allocate to Low Tax Associate
Just make the loan to a low tax associate. If you have a shareholder at a top marginal rate and a spouse with no income – just make the loan to the spouse. The spouse includes the deemed dividend in their tax return but enjoys low tax brackets.
Fix # 5 Ask Commissioner for Discretion
You can apply for the Commissioner’s discretion when the Div 7A problem happened inadvertently or due to an honest mistake. If you can show this, you will have a success rate of about 80%. To apply for the discretion, you have to apply for a private ruling.
Exlusion # 1 Make it Company To Company
A loan from one company to another company will not trigger a Div7 A deemed dividend.
Exlusion # 2 Find Already Assessable
If a loan is already assessable income under another provision of the income tax act, then it can’t be assessable income under Div 7A.
Exlcusion # 3 Make It Business As Usual
If a loan is made in the normal course of business and it is made on the same terms to a shareholder or associate of that company as to normal customers, then it would not translate into an unfranked deemed dividend.
Exclusion # 4 Make It a Loan by a Liquidator
If a liquidator makes a loan to the shareholder in the course of winding up the company, then it doesn’t fall under Div 7A.
Exclusion # 5 Employee Share Scheme
If a shareholder acquires shares of a company but the company advances the funds to the employee to buy the shares of the company, the loan does not fall under Div 7A.
Summary
So these are 10 ways to get out of a Div 7a problem.
You pay it back or you set up a s109N loan document with minimum repayments and interest each year, so you make it a genuine commercial loan.
Or you find ways to reduce the distributable surplus. Your 4th option is to make the Div 7A loan to a low tax associate, include the deemed dividend in their assessable income but stay in low tax brackets. And your 5th fix is to ask the commissioner for their discretion.
Your other option is to find one of the five exclusions. You make it company to company loan. Or you find that the loan has already been recognised as assessable income. Maybe you are a finance house and make it business as usual. Or it is a loan from a liquidator to the shareholder. And the final exclusion is loans as part of an employee share scheme.
If you can find one of these 10 fixes or exclusions, your Div 7A problem is no longer a problem.
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Disclaimer: Tax Talks does not provide financial or tax advice. All information on Tax Talks is of a general nature only and might no longer be up to date or correct. You should seek professional accredited tax and financial advice when considering whether the information is suitable to your or your client’s circumstances.
Last Updated on 01 May 2020
Tax Talks spoke to Peter Adams - Principal at Augmentors - for more details.
